'I'll get my money back because of the printing machine': One pro investor on why he's happy lending to the UK government

FUND FOCUS: A stock-picker who aims to provide income while dodging big risks

Investors, understandably, have become increasingly jittery about losing their money.

They have, after all, endured more than a decade of roller-coaster markets which, depending on your timing, are likely to have delivered measly returns.

The industry has reacted to meet this demand by launching funds that promise to do their best to smooth out these violent swings - and still provide decent profits or reliable income.

Fund data M&G

This, of course, is the Holy Grail of
investment: making money but by taking minimal risk. It's difficult to achieve.

M&G Episode Income is one such fund taking up the quest.

It had a solid start after launch
in late 2010 with manager Steven Andrew nimbly side-stepping the worst of
the sell-off triggered by the eurozone crisis last autumn.

He
has been aided partly by taking a big bet on gilts. Many fund managers
have expressed concern about backing these government bonds, which are
effectively loans to the already debt-laden British taxpayers.

But they have been proved wrong of late with the value of bonds surging in 2011 and early 2012.

The
fund's performance has been more sedate since then, pretty much matching
the average fund of this type (see the graph). That is largely because
the rally in government bond prices has been outpaced by a resurgent
stock market, especially in the past six months. Rival funds may have taken bigger stock market bets.

Part
of M&G's range of funds that pick from a wide range of assets,
Steven Andrew has been tasked with slavishly avoiding volatility - so
investors have a better chance of taking out their money short-term
without incurring a loss - while still delivering decent income.

Datastream | M&G

The
£119million fund puts just 40 per cent of its money in stock markets with the biggest
bets placed on the US and China. It has shunned European shares, despite
claims from some experts that stock markets such as Italy look
dirt-cheap compared with historic prices.

Andrew also avoid government bonds on the Continent.

'It's not that I wouldn't invest at any price,' he says, 'but they aren't that cheap versus the risk.'

He
says there are other places to hunt out income where the risk is lower. He has bought bonds offered by governments in emerging markets,
which compensate backers with far higher yields than in Europe. His emerging market bets are on Mexico, the
Philippines, South Africa and Malaysia.

Green shoots?: The Bank of England has deployed electronic money printing on a mass scale to encourage economic growth

Despite
a flurry of headlines warning of a bond bubble, he doesn't believe a
pop is imminent. The pessimists warn that two things could spark a
sell-off: if the UK economy bounces back to health, investors would dump
bonds for riskier assets like shares; or international investors could
become concerned about the UK's ability to meet its debt repayments.

Andrew
said he is a 'pretty nervous holder' but added: 'I know I'm going to
get my money back on gilts because there is a man with a machine that he
can use to print money. There is, of course, a question around what I
can buy with that money.'

In
other words, the UK can keep paying its investors if electronically created money from the Bank of England's quantitative easing programme continues to hold down the cost of borrowing for the Government. But this could create inflation. Even in the scenario of inflation rising to just 5 per cent, the fixed income paid on those bonds - currently 1.74 per cent
on 10-year gilts - begins to look pitiful. Investors are effectively losing money so they sell the asset: prices fall, bond funds suffer.

But
Andrew believes deflation remains the greater threat: 'In order for
stuff to continue to get dearer, people need to be able to afford to buy
that stuff.' He said that without significant growth in the economy and
wages, that scenario is unlikely.

That
said, he has scaled back his exposure to gilts from 17 per cent last
year, when they paid 4 per cent, to just 9 per cent today with the yield
at at just 1.74 per cent.

How M&G Episode Income was invested in November

M&G has a reputation for expertise in bonds - it is one of the UK's largest investors in these assets. But is the fund, which yields nearly 4 per cent, right for you and should you back it?

Martin Bamford, a chartered financial planner at the adviser Informed Choice, says:
'This fund could suit investors who are looking for a steady income but
have concerns about too much exposure to gilts and corporate bonds with
yields at their current lows. The ability for the manager to allocate
across several investment asset classes, within known ranges for each,
means he can be more flexible in his approach than a manager who only
invests in gilts or bonds.

'This fund still has a relatively short
performance track record, and we would prefer to see at least one more
year before drawing any conclusions about performance. Funds typically
appear on our radar for more detailed consideration once they have
established a three year track record.'

As an alternative he suggests Jupiter Merlin Income Portfolio, which operates in a similar way but operates as a fund of funds, so can cherry pick potential star funds in each asset class.

But it comes at a cost, says Bamford, with an annual charge (total expense ratio) of 2.33 per cent compared to 1.86 per cent
for the M&G Episode Income fund.

He adds: 'The Jupiter Merlin
Income Portfolio has returned 10.9 per cent over the past year compared to
8.86 per cent for the M&G fund, so the higher charges have been justified.
Over the past five years, the Jupiter fund has returned 30.39 per cent compared
to an average return of 12.28 per cent in the IMA Mixed Investment 20-60% Shares
sector [its peer group].'

Bamford added that he preferred to advise customers to build a portfolio covering the assets that are right for the investor, but doing this through backing single funds that invest in one asset.